blanchard_ch10

00 break even point atc 2500 2000 mr 1500 0 8 10

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Unformatted text preview: aters per day) (a) Break even Price and cost (dollars per sweater) Price and cost (dollars per sweater) FIGURE 10.8 profit-maximizing number of sweaters produced. The blue rectangle shows this economic profit. The height of that rectangle is profit per sweater, $4.67, and the length is the quantity of sweaters produced, 9 a day. So the area of the rectangle is economic profit of $42 a day. Figure 10.8(c) corresponds to the situation in Fig. 10.7(b) where the market demand is D3. The equilibrium price of a sweater is $17. Here, the price is less than average total cost, so the firm incurs an economic loss. Price and marginal revenue are $17 a sweater, and the profit-maximizing (in this case, lossminimizing) output is 7 sweaters a day. Total revenue is $119 a day (7 $17). Average total cost is $20.14 a sweater, so the economic loss is $3.14 per sweater ($20.14 – $17.00). This loss per sweater multiplied by the number of sweaters is $22. The red rectangle shows this economic loss. The height of that rectangle is economic loss per sweater, $3.14, and the length is the quantity of sweaters produced, 7 a day. So the area of the rectangle is the firm’s economic loss of $22 a day. If the price dips below $17 a sweater, the firm temporarily shuts down and incurs an economic loss equal to total fixed cost. MC 30.00 ATC 25.00 Economic profit 20.33 15.00 0 9 10 Quantity (sweaters per day) (b) Economic profit In the short run, the firm might break even (make zero economic profit), make an economic profit, or incur an economic loss. In part (a), the price equals minimum average total cost. At the profit-maximizing output, the firm breaks even and makes zero economic profit. In part (b), the market price is $25 a sweater. At the profit-maximizing output, animation MR Price and cost (dollars per sweater) 204 MC 30.00 ATC 25.00 AVC 20.14 17.00 Economic loss 0 MR 7 10 Quantity (sweaters per day) (c) Economic loss the price exceeds average total cost and the firm makes an economic profit equal to the area of the blue rectangle. In part (c), the market price is $17 a sweater. At the profitmaximizing output, the price is below minimum average total cost and the firm incurs an economic loss equal to the area of the red rectangle. 000200010270728684_CH10_p195-220.qxd 6/23/11 4:13 PM Page 205 O utput, Price, and Profit in the Long Run x Output, Price, and Profit Economics in Action Production Cutback and Temporary Shutdown The high price of gasoline and anxiety about unemployment and future incomes brought a decrease in the demand for luxury goods including high-end motorcycles such as Harley-Davidsons. Harley-Davidson’s profit-maximizing response to the decrease in demand was to cut production and lay off workers. Some of the production cuts and layoffs were temporary and some were permanent. Harley-Davidson’s bike production plant in York County, Pennsylvania, was temporarily shut down in the summer of 2008 because total revenue was insufficient to cover total variable cost. The firm also permanently cut its workforce by 300 people. This permanent cut was like that at Campus Sweaters when the market demand for sweaters decreased from D1 to D3 in Fig. 10.7(b). R EVIEW QUIZ 1 2 3 How do we derive the short-run market supply curve in perfect competition? In perfect competition, when market demand increases, explain how the price of the good and the output and profit of each firm changes in the short run. In perfect competition, when market demand decreases, explain how the price of the good and the output and profit of each firm changes in the short run. You can work these questions in Study Plan 10.3 and get instant feedback. 205 in the Long Run In short-run equilibrium, a firm might make an economic profit, incur an economic loss, or break even. Although each of these three situations is a short-run equilibrium, only one of them is a long-run equilibrium. The reason is that in the long run, firms can enter or exit the market. Entry and Exit Entry occurs in a market when new firms come into the market and the number of firms increases. Exit occurs when existing firms leave a market and the number of firms decreases. Firms respond to economic profit and economic loss by either entering or exiting a market. New firms enter a market in which existing firms are making an economic profit. Firms exit a market in which they are incurring an economic loss. Temporary economic profit and temporary economic loss don’t trigger entry and exit. It’s the prospect of persistent economic profit or loss that triggers entry and exit. Entry and exit change the market supply, which influences the market price, the quantity produced by each firm, and its economic profit (or loss). If firms enter a market, supply increases and the market supply curve shifts rightward. The increase in supply lowers the market price and eventually eliminates economic profit. When economic profit reaches zero, entry stops. If firms exit a market, supply decreases...
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This note was uploaded on 01/10/2013 for the course ECON 251 taught by Professor Blanchard during the Spring '08 term at Purdue.

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